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House Testimony: The Challenge of Distributing Carbon Allowances under
Cap-and-Trade

A cap-and-trade program to control greenhouse gases will introduce into the economy property rights ranging from $100 billion to $370 billion every year in the form of tradable emissions allowances – constituting the greatest creation of government-enforced property rights since the 19th century.

That projection, from Resources for the Future Senior Fellow Dallas Burtraw, came in his testimony before the House Ways and Means Committee September 18. The initial assignment of the market value of the allowances is thus the most important element of the design of a cap-and-trade program, Burtraw said.

Simple tax reforms, or – simpler still – direct dividends to households, are approaches that would provide the most convincing signals to the public that the United States is addressing climate change as a national initiative, and not one that is engineered to squirrel away special privileges, he said.

Dallas Burtraw
Dallas Burtraw
RFF Senior Fellow

 
“Policymakers might frame the decision about allocating emissions allowances in the following way,” said Burtraw. “Imagine we are implementing a new program that will create well over a trillion dollars in value in the next decade. Now, how do you want to allocate that value?”

The award of free CO2 emissions allowances is equivalent to a grant of cash, Burtraw noted, and generally has no effect on production decisions or the price of goods and services in the economy. One exception is the electricity sector, because in much of the nation, regulators set electricity prices to recover justly incurred costs.

A potential justification for free allocations to incumbent emitters, as occurred with the SO2 trading program, is to compensate entities that are severely harmed by a policy. However, Burtraw noted, free allocation creates the possibility of windfall profits and is decidedly regressive. Research by Burtraw and his colleagues shows that firms can be fully compensated through free allocation of just 11 percent of the allowances used in the regulated regions.

 Burtraw Testimony
Download the Testimony (PDF)

Burtraw discussed other policy options for distributing the value of emission allowances.  Using the revenue from an allowance auction to reduce the income or payroll tax performs well on an economic efficiency basis, but is likely to be regressive because lower income households would benefit less from the tax reduction, while bearing a relatively large burden from higher energy costs.

In addition, he said, there are other policies that would convert the regressive nature of the CO2 price into one that is modestly progressive. These include expansion of the Earned Income Tax Credit and a cap-and-dividend program that would return revenue directly to households. Another modestly progressive policy would be investing in efficiency.

One alternative that has received attention lately would be free allocation to local distribution companies that sell electricity to retail customers and are universally regulated across the country. In practical terms, this would shift the burden of reductions to other sectors, like transportation and home heating.

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